Guest Post: They Don’t Call Them Real Interest Rates For Nothing

Tyler Durden's picture

Submitted by John Aziz of Azizonomics

They Don’t Call Them Real Interest Rates For Nothing

A reader asks:

I had a chat with a wealth management advisor from a well-known financial institution, who was bullish on short duration bond funds due to ”the FED’s complete control with regards to suppressing and maintaining short-term interest rates.” I was wondering if you had any articles on what factors (other than the FED, if any) contribute to and continue to suppress short-term interest rates in the US and what potential facts could reverse this trend?

The Fed exerts a great deal of control over nominal interest rates. While the Treasury and Fed maintain the pretensions of an open and transparent market where national and international demand for government securities is generated organically, the reality is that the Fed can monetise anything that the market rejects to achieve any desired nominal interest rate. This applies equally to all securities; though the Fed allows the 10-year and 20-year to float more freely, Operation Twist shows the Fed can control the nominal yield curve if they so wish.

The Fed’s power to control nominal rates is shown quite clearly — as the economy remained in a liquidity trap following 2008, the Fed implemented policies (QE, Twist, ZIRP) to make treasuries expensive ostensibly to discourage hoarding and stimulate aggregate demand (and — so helpfully — keep the Treasury’s interest burden low):

What the Fed cannot really control is the rate of inflation, the other variable that makes the real interest rate, and the key variable in determining whether Treasuries are a winning or losing bet.

Here’s the real rate on the 2-year over the same period:

On computing the graph, my jaw almost hit the floor; real interest rates on the 2-year today are higher than they averaged during the boom years up to 2007. The Negative-Interest-Rate-Policy isn’t so new at all. All the Fed’s accommodative action has been almost meaningless — it has hardly reduced the real interest rate at all from the pre-crisis norm (although the most recent spike into positive real territory is the strongest argument for imminent quantitative easing that I have seen in a long time — Krugman, Avent, DeLong, Yglesias, take note).

On the other hand, there are clear patterns in real rates over longer periods. Here’s the 2-year, 5-year, 10-year since 1980:

But this doesn’t prove that the Fed can really exert control over real rates. However the graph suggests very strongly that Greenspan took his eye off the ball in terms of real interest rates; as real rates continued to fall, Greenspan wasn’t raising nominal rates, as might be expected of a Fed chairman looking to prevent bubble-formation.

Simply, the idea that short-duration bond funds are a good bet due to “the FED’s complete control with regards to suppressing and maintaining short-term interest rates” is completely wrong on every level; they’ve been a losing investment in real terms for most of the last 5 years, and the Fed is determined to keep it that way. The Fed’s control over nominal interest rates is precisely the reason that I wouldn’t want to invest in treasuries; not only has it consistently made bonds into a real losing proposition, but it also creates a good deal of systemic currency risk. Simply, the Fed will — in the pursuit of low-rates — monetise to the point of endangering the dollar’s already-under-threat reserve currency status. The only things that would turn bonds into a winning proposition — rising interest rates, or deflation — are anathema to the Fed, and explicitly opposed by every dimension of current Fed policy.

Of course, creating artificial demand for treasuries to control nominal rates has blowback; if the buyers are not there, the Fed must inflate the currency. Hiding inflation is hard, so it is preferable to a central bank that old money is used; this is why Japan has mandated that financial institutions buy treasuries, and why I fear that if we continue on this trajectory, that the United States and other Western economies may do the same thing.

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francis_sawyer's picture

lol ~ MK goes ballistic...

MillionDollarBonus_'s picture

"real interest rates on the 2-year today are higher than they averaged during the boom years up to 2007 ... All the Fed’s accommodative action has been almost meaningless"

This is grossly inaccurate. The 2-year yield has risen due to expectations of a renewed operation Twist. The yields on longer dated treasuries will remain low for the foreseeable future due to safe-haven demand from investors, sovereign nations looking to build their dollar reserves AND due to the wise and sensible accomodative actions of our Federal Reserve and congress. I know it's difficult for doomer goldbugs to accept, but it's the truth.

Zero Govt's picture

MDB   "..the wise and sensible accomodative actions of our Federal Reserve and Congress... it's the truth."

The "wisdom" of out-of-control debt-spending by Congress, this economic lunacy/tragedy bank-rolled by the Fed printer

..then Benny has the gumption to tell Congress they need to control their spending, the spending he's been bank-rolling?!!

the lunatics have taken over the asylum, MDB you're in there with them

falak pema's picture

MDB writes good prose in a bad cause; thats called poetic licence of free lightweight mind with a contrarian bend. It could be a cloak to hide his real intent

"One flew over the cuckoo's nest" would be an appropriate title to your rant.

OneTinSoldier66's picture

It's not difficult to see an attempt at Mind Control, unless you have a weak mind. Just as it easy to see an attempt at market command and control.

Divided States of America's picture

Fuckin Hell, if Libor is being manipulated, I am sure the inflation rate is also...and Ben Bernanke keeps saying the same shit "Inflation is tame, Inflation is well contained". My ass it is, you mofo.

Debtless's picture

My lack of interest in these markets is compounding daily now.

Hi Tulving, I'd like to place another order please. Yes, I know I called earlier today as well.

disabledvet's picture

Without growth in the US economy the "real rates" will stay at or near zero as well. I'm tired of arguments targeting the Fed...we have all been right here morally but absolutely wrong empirically. We have to pick our fights now...I recommend by not picking any right now save for the EZ.

Ghordius's picture

disabledvet, LOL - because you think the EZ is easier to break than the FED(s)? i.e. for "tactical reasons"? or what?

you might be tired of arguments, but I still have to read/understand what a complex multi-FX-peg done in defense of a continental economy from the ravages of eurodollars fluctuations has done to you to hate it so fervently. would you be happier if europe would belong to the dollarzone? or would you prefer 17 national CBs organizing currency grids or devaluation battles?

you belong to a group of very misguided young people, IMO, you still have to swallow the other half of the red pill.

GeneMarchbanks's picture

Propagandized not misguided. The power of suggestion pure and simple. This board doesn't really question very much very deeply. The WTO, WIPO, UN and you could even say the IMF pretty much go ignored which is exactly why the Anglo-sphere is growing more isolated by the day. Is it any wonder why people like Keiser, Jim Willie and even that clown Jim Rogers have to not only be outside the UK and US but also the Common Wealths to get any coverage at all?

Ghordius's picture

well, I have fresh hopes for the UK. the British Muppets have taken the Libor scandal more seriously than I thought possible, many are truly shocked and there was a complete reversal of the British position on many cases.

there is even talk of letting the ECB or any suitable EU organ clean up the mess in the Square Mile - which smacks of nobody wanting to touch it locally, neither the BoE nor the Cameron Cabinet.

IMO, it looks like the fog is lifting and the British Elites are becoming aware of what the options really are instead of carrying on, regardless...

Britons, bless them, are mostly a germanic people, when they start to apply the shame card it's serious

magpie's picture

That was so bloody obvious that this was the 'crisis' to herd the Britishers into the Euro fold.

Ghordius's picture

to "herd"? why? the UK could still call the US for help, instead of the continentals. how about that? ;-)

magpie's picture

I wonder what happened to AEP 

OneTinSoldier66's picture



Interest Rates will stay at or near zero for as long as you and/or Ben Bernanke judge the economy to be weak, and they will remain low because you and/or Ben Bernanke say they are to remain low, right? Do you or Ben have any timeline as to when you might 'allow' the free market into the picture? Or do you guys just not believe in free markets?


Let me guess, you and Ben Bernanke also said that the price of homes will never come down.

kito's picture

.....bullish on short duration bond funds due to ”the FED’s complete control....

shirley a sign of the world gone mad when some jackass wealth managment advisor can use the word "bullish" in the same sentence with the phrase "feds complete control"..............

Snakeeyes's picture

Well, that is the ex-post measurement of real rates. It is better to examine the interest rate less the EXPECTED rate of inflation. Using an ARMA or similar procress.

TheCanadianAustrian's picture

Are we talking about "real" interest rates as calculated using the government-decreed CPI?

If so, why should I not dismiss this whole article outright?

Jason T's picture

food price index tanking, inflation y/o/y now at 1.70% as of May, wages growing only 1.35% for production workers and total personal income only growing 2.6% ... total credit growth only growing 2.5% as well..


I smell deflationary depression

kito's picture

that deflationary fire has been burning for some time now........have your nose checked............all the kings horses and all the kings men, havent been able to get gold over 1900 again........................

Jason T's picture

wage growth, nominal, lowest going back to at least 1965 when it was nearly 4% year over year.. it hit a low of 1.6% in 1986, but the latest read is just 1.4% y/o/y .. inflation is 1.7% as of May, so  a negative real rate increase to boot.

In Feb, we got a report about NY employement.. by the end of 2011, NY regained 46% of jobs lost in the recession.. LI actually lost an additional 2500 jobs.. but the average salary of newly created jobs paid 40% less than pay of the jobs lost.

be glad if you don't get a pay cut in 2012 and 2013 let alone still have a job.

Amish Hacker's picture

I'm not so sure about food prices tanking. DBA ( )is off and running this month after a double bottom, and the CORN chart ( ) inspires vertigo. Meanwhile, we have record hot weather across the US midwest and southeast, bad harvests in northern China and several other parts of the world, and rising oil prices. Don't count on low food prices as a given.

Jason T's picture

can't argue that.. what I can count on i think is demand destruction.. 

Vet4RonPaul's picture

dudes, i don't know how they do it but I have made great returns on Vanguard and Fidelity treasury funds.  And I'm not talking about slightly over inflation; I'm talking a good 10% over inflation.  Check their returns out - even Seeking Alpha shows them at the top of the list on their Macro View page.  I put some of my money on treasuries because I thought they were low risk, but in fact I really gotten great returns for ten years now.  I'm still a physical gold and silver freak but I can't complain about the US treasuries and how ever the mutual funds turn them into real money for me.

cosmictrainwreck's picture

it's called CAPITAL GAINS.... Treasuries have screamed higher for 15 months due to plunging interest rates you might want to take some money off the table on the possibility rates creep; TLT already rolling over last 10 days

Winston Churchill's picture

The CB's will not stop at forcing banks to buy junk bonds(UST's included in that

statement).They are coming for your 401k's.

Be sure of it.Not if, it's when .

Aziz's picture


Obamacare provides the precedent.

Enjoy your retirement.

donsluck's picture

Agree, kinda. It wasn't the law that provided precedent, it was the Supreme Court that INTERPRETED the fines as "taxes" (like corporations are "people" and money is "speech").

Hedgetard55's picture

"All your 401Ks are belong to us".

Bansters-in-my- feces's picture

It's very clear that MDB is a goverment shill by the article he comments on and what side he stands on.

In case your still on site MDB, Fuck Off you piece of shit.

TheCanadianAustrian's picture

You obviously haven't paid attention to enough of his posts. He's a comedian.

I should be working's picture

"The only things that would turn bonds into a winning proposition — rising interest rates, or deflation — are anathema to the Fed"

What? Rising interest rates would be horrible for the bond market. Deflation is the only positive surprise left.

donsluck's picture

I noticed that too, weak thinking. Rising interest rates are bad for all bond holders, dropping rates are good. It's more about the direction then the level. The interest is fully taxable, the cap gains are taxed at the reduced rate, so cap gains are more important.

Aziz's picture

"Making money" on bonds in this environment from a cap gains perspective is bubble territory. Fine for a while, but eventually you will run out of greater fools.

Like playing pass the parcel with a stick of dynamite.

GCT's picture

This LIBOR scandal smells fishy to me all.  I think Barclays is taking the fall for the bigger fish myself.  To manipulate the LIBOR it would take all the big players in the game to ok this.  Am I seeing this wrongly?  I think this goes all the way to the FEd and the German CB as well.  This will blow over and no bankers will go to jail or they will offer up one for the alter and brush the rest under the table.

slewie the pi-rat's picture

this doesn't prove anything except that is you adjust for inflation you get a different answer about "rates" than if you don't

when the measure of inflation which is "built into" these econometricks turns negaive, as recentlly has happened and which people who actually look at commodity prices once in a while may KNOW, it does give the 2-year "real rate" a nice little boner and yes, for those with bruised or unhinged jaws it doesn't happen very often in the fiatsco world, but since the FED has actually ceased (publicly at least we might all agree)  LSAP, happened right here recently and we all watched it whether we were aware of it at the time or not

if i put this link up any more frequently here when i talk about this, i may get sued!  comm_futures

this is (agian) the year-chart of the 4 commodity indices carried on the bloomie commodities4idiots page ever single fuking day

here we see what actually caused what this "surpise" is all about and if people aren't too busy to actually LQQK at what is happening in the one place where prices have NOT been screwed down TIGHT, they would ALSO see that that the INflation indicator  has spiked quite a little boner itself, here;  if you don't see it, get help now

imo, that would be the actual NEWS here if anyone cares...  to wit:  that this chart these brainiacs are publishing here has already completely reversed